Take the Pension Buyout or Wait for a Better Deal?

August 13, 2014

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If you work for a company with a pension plan, don’t be
surprised if you get an offer soon for a lump sum buyout - a deal where you
accept a pile of cash in exchange for the promise of lifetime income when you
retire. The price tag for these offers is especially attractive right now, from
the plan sponsor’s perspective. But workers might do better by holding out for
a better deal, or by rejecting the buyout altogether.

A growing number of plan sponsors are trying to get out of
the pension business, or lighten their obligations, by buying out workers. The
number of buyout offers has accelerated in recent years, in part because of
interest rate changes mandated by Congress that reduce their cost to plan
sponsors.

Now, revised projections for average American longevity are
giving plan sponsors new reasons to accelerate buyout offers. New Internal
Revenue Service actuarial tables that take effect in 2016 show average
lifespans up by about four years each for men, to an average of 86.6 years, and
women, to 88.8 years.

The new mortality tables will make lump sum offers 3 percent
to 8 percent more expensive for sponsors, according to a recent analysis by
Wilshire Consulting, which advises pension plan sponsors. Another implicit message
here is that lump sum offers should be more valuable to workers who take them
after the new mortality tables take effect.

The reason for his uncertainty is the future direction of
interest rates. If rates were to rise over the next couple years from today’s
historic low levels, that would reduce lump sum values enough to offset
increases generated by the new mortality tables.

Deciding whether to accept a lump sum offer is highly
personal. A key factor is how healthy you think you are in relation to the rest
of the population. If you think you’ll beat the averages, a lifetime of pension
income will always beat the lump sum.

Another consideration is financial. Some people decide to
take lump sum deals when they have other guaranteed income streams, such as a
spouse’s pension or high Social Security benefits. The size of the proposed
buyout matters, too. If you’ve only worked for your employer a short time and
the payout is small, it may be convenient to take the buyout and consolidate it
with your other retirement assets.

Some people think they can do better by taking the lump sum
and investing the proceeds. It’s possible, but there are always the risks of
withdrawing too much, market setbacks or living far beyond the actuarial
averages, meaning you would need to stretch that nest egg further. And doing
better on a risk-adjusted basis means you would have to consistently beat the
rate used to calculate the lump sum by investing in nearly risk-free
investments since the pension income stream you would receive is guaranteed.